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To frack or not to frack?

In recent years, the production of shale gas by using hydraulic fracturing (“fracking”) has become an increasingly important factor in providing the required energy production worldwide. In 2012, already 40% of the total US gas production was provided by shale gas resources. According to the study of the US Energy Information Administration (EIA) on worldwide shale gas resources (published in June 2013) the estimated resources of technically recoverable shale gas amounts to 7,299 tcf (trillion cubic feet) worldwide. The countries with the biggest resources are Argentina, Australia, Brazil, Canada, China, Mexico, Russia, South Africa and the US. These countries represent 70% of the worldwide available shale gas resources.

However, currently only the US and Canada are producing shale gas in commercial quantities. Whether or not a fracking project makes sense from an economic perspective depends on a multitude of factors, including geological formation, above-the-ground conditions (including density of population), the political environment, as well as the tax and legal framework.

Taxand's global energy tax team, including Taxanders from Australia, China, Germany, Mexico, Netherlands, Poland, UK and USA, provides a summary of the relevant framework in selected jurisdictions and the potential implications for MNCs operating within the energy sector.

China

The estimated land resource of shale gas in China amounts to 4,747 tcf (trillion cublic feet) and the amount of technically recoverable shae gas is expected to be 883 tcf (excluding the Tibet region). In general, mining shale gas resources in China is a promising business not only because there are abundant resources but also the Chinese government will take foreseeing steps to implement encouraging polices on shale gas industry. Currently VAT is applicable at the point of selling shale gas only.Discover more >

US

The estimated resources of technically recoverable shale has in the US amounts to 1,161 tcf (trillion cubic feet) and 48 billion barrels of technically recoverable shale oil (the largest amount of shale gas compared with others in the US EIA report). Natural gas plays a key role in the US clean energy future. As of 2013, over two million oil and gas wells in the US have been fracked, and hydraulically fractured wells make up over 43% of the oil and 67% of the current natural gas production in the US. From a tax perspective, the US does not provide for special provisions or tax incentives for fracking projects. Master Limited Partnerships (MLPs) are a popular structure for companies within this industry however. Read more >

Mexico

Mexico has signficant resources that correspond to 7.5% of the worldwide reservoirs. Currently oil production (including fracking projects) continues to be subject to the Pemex (Mexico's national oil company) monopoly. From a tax perspective, Mexico does not provide for special provisions or tax incentives for fracking projects however this may change soon. Mexico’s Congress is currently analysing three energy reform bills and it is the general consensus that the political environment is ripe in Mexico for a comprehensive energy reform and that such reform will be approved before year’s end. Discover more >

Australia

Hydraulic fracturing is a hot political topic in Australia right now. Given Australia’s limited water resources, problems with soil salinity and reliance on agriculture, the political debate is focused on the environmental issues. There are no special tax provisions for hydraulic fracturing in Australia. Rather, the capital allowance provisions apply to the industry in the same way as they apply to other extractive industries. The Standing Committee on Environment and Public Affairs of the Legislative Council of Western Australia recently announced an enquiry into the implications of hydraulic fracturing for unconventional gas in the State of Western Australia. The enquiry will investigate the impact on land use, the regulation of chemicals, ground water use and the rehabilitation of land. The enquiry is the first of its kind and is expected to generate widespread international interest. Read more >

UK

The UK government believes that shale gas has a huge potential to transform the UK’s energy supply by reducing the country’s growing dependence on imported gas. Initial exploratory activity is taking place in several locations in the UK to determine the accessibility and commercial viability of shale gas. At present there is no special tax regime for the exploitation of shale gas in the UK. The exploitation of shale gas will be subject to the ring fence tax regime for oil and gas. The overall effect of this regime is an effective tax rate of up to 62%, but with accelerated allowances for capital expenditure.

In the 2013 Budget, the UK Chancellor announced plans for a consultation on a fiscal regime for shale gas to offer incentives to companies intending to exploit shale gas reserves in the UK. The consultation document, published in July, invites responses from industry stakeholders and professional firms with the intention for feeding back responses towards the end of 2013 and new legislation to be included as part of the Finance Bill 2014. Discover more >

Poland

According to the US EIA report, the total shale gas resources in Poland are estimated at 4.2 tcm, which reflects approximately 30% of all European assessed resources (2% worldwide). The legal framework for the exploration of shale gas in Poland is above all determined by the Geological and Mining Act. From a tax perspective, independenttly from the general income taxes, Poland is considerings imposing a tax on the extraction of shale gas that is called ‘the special hydrocarbon tax’. Under the legislative proposal, the act on special hydrocarbon tax will be entered into force in 2015, however, taxpayers will have to pay the tax from the beginning of 2020. the main issue that needs to be resolved is the uncertainty concerning legal framework of the exploration, as there are still no final regulations of the administrative and tax law in this regard. Read more >

Netherlands

The shale gas development in the Netherlands is a slow moving process, which is highly influenced by the political process. The exact quantum of shale gas in the region is yet to be determined. The exploration and exploitation falls under the same tax, legal and regulatory regime as the conventional oil and gas exploration and production. Therefore, also the state profit share applies, taxing the profits at a rate of 50%. Most political parties in the Netherlands are in principal welcoming shale gas. Nevertheless, more studies are requested regarding the environmental effects and risks. Discover more >

Germany

The US EIA report estimates that the resources of technically recoverable shale gas in Germany amount to 17 tcf (approx. 0.2% of the worldwide reservoirs). Currently, there are no special law provisions for hydraulic fracturing in Germany, Thus, the general rules of German environmental law have to be applied, in particular the German water and mining law. From a tax perspective, Germany does not provide for special provisions or tax incentives for fracking projects. Read more >

MNCs should note the insecurity of their tax position when it comes to shale gas projects, and monitor closely the legislative change that is in play. While it can be noted that shale gas and fracking are definitely on the agenda of all countries that have been analysed, to date no country provides for special tax provisions for such projects. The UK and Poland are currently considering the introduction of special tax rules for shale gas projects. In the UK, this includes the introduction of tax incentives. So far, China is the only country in this analysis that provides subsidies for fracking projects. In the US, shale gas and fracking projects can be operated within master limited partnership structures which provide the access to capital like a publicly traded corporation, just without the entity level of taxation.

Taxand's Take

While investors always need to be aware of the potential insecurity of their tax position when it comes to long term projects, this is particularly true with regard to shale gas projects. As in many countries, no decision has been taken yet whether fracking should be promoted or rather restricted, the tax environment may change significantly. Managing the tax position of fracking projects is very important in order to get to an acceptable level of security. Planning and acceptable and stable effective rates are crucial.

In almost all countries, the environmental concerns connected to fracking, and the public opinion in this respect, play an important role in the political environment, thus causing insecurity regarding fracking’s potential chances worldwide. Apart from the environmental issues at stake, there are far more non-tax aspects of fracking: it is not only a matter of countries seeking independence from gas imports, but is also a source of local employment - often in areas that are currently employment blank spots. Furthermore, shale gas will likely have a significant impact on the international gas market, as net importers of energy may become net exporters of energy. This of course will have a significant impact also on the businesses surrounding this development -(the transfer of technology is just an example of the impact. Unlike the traditional flows, these flows could go in the opposite direction which should be considered in the tax planning of eg IP and royalty structures.